Auditing Standards in Accounting and Medicine

Auditing Standards in Accounting and Medicine

Wed, 4 Jun 2003

“Those financial calamities made it brutally clear that the present audit standards and practices are severely deficient, since the failing enterprises had managed to issue misleading financial reports that nevertheless were attested to and blessed at the time by “see no evil” auditors from the then-Big Five accounting firms.”

An article in Accounting Today, by my husband (below) criticizes the corrupt auditing practices of the accounting establishment, and its failure to protect investors.

The criticism applies equally to the corrupt practices of the pharmaceutical/ medical industry and the failure of oversight agencies to protect the public health. Medical research and pharmaceutical marketing practices have so far escaped scrutiny by independent auditors.

The latest hazard to public health is an effort to fill the void left by PremPro, the discredited hormone replacement therapy for menopausal women. The drug being promoted in the Journal of the American Medical Association to fill that void is Paxil (a.k.a. Seroxat, Paroxetine), an addictive antidepressant of the SSRI variety. When the BBC (Panorama) revealed the drug’s addictive effect in a highly acclaimed investigative series, the manufacturer, GlaxoSmithKline, agreed to change the drug’s label in the UK–not in the US. See: AHRP Infomail, May 21 at: http://www.ahrp.org/infomail/0503/21.php See: JAMA 2003;289:2827-2834: http://jama.ama-assn.org/cgi/content/abstract/289/21/2827 “Paroxetine Controlled Release in the Treatment of Menopausal Hot Flashes A Randomized Controlled Trial.” The report concludes: “Paroxetine CR may be an effective and acceptable alternative to hormone replacement and other therapies in treating menopausal hot flash symptoms.”

Curiously, the “study” tested Paxil in “165 menopausal women aged 18 years or older…” Since when are 18 year old women menopausal????

~~~~~~~~~~~~~~~~~~~~ ACCOUNTING TODAY If Sarbanes-Oxley is to work, be wary of certain offers

by Itzhak Sharav*

Since the passage of the Sarbanes-Oxley Act and the creation of the Public Company Accounting Oversight Board, the American Institute of CPAs – a trade organization whose most influential constituents and financial mainstay are the Big Four public accounting firms – has been waging a campaign, so far without success, to secure a more prominent role for the accounting establishment in the new regulatory environment.

Lending his voice to the campaign, AICPA chair William F. Ezzell, in a December address delivered at the AICPA’s annual SEC conference in Washington, claimed to have the public’s interest in mind.

Ezzell urged the new PCAOB – whose task it is to set standards to be followed by auditors of public companies – to cede, in effect, much of its authority to those auditors, and rely on the present standard-setting processes, "by calling on the experience of the men and women who are on the front lines, doing audits every day, and learning from every audit they conduct." Chairman Ezzell’s address was a siren song that, if heeded, would have made a mockery of Sarbanes-Oxley, by signaling the undoing of the far-reaching changes that the act was meant to usher in.

After all, that reformist legislation – which the AICPA opposed and lobbied hard to water down by promoting the original and much weaker version pushed forward by Rep. Michael B. Oxley, R-Ohio, an old ally of the accounting industry and a beneficiary of much of its largesse – was passed subsequent to the collapse of the Enron Corp., the biggest energy-trading company in the country.

That was followed by the numerous other corporate debacles, accounting distortions and massive audit failures that came to light in rapid succession – beginning in the fall of 2001, and continuing through the first half of 2002.

Those financial calamities made it brutally clear that the present audit standards and practices are severely deficient, since the failing enterprises had managed to issue misleading financial reports that nevertheless were attested to and blessed at the time by "see no evil" auditors from the then-Big Five accounting firms.

Those firms failed to alert the investing public to undisclosed hazards that put into question the viability of those companies as going concerns. The auditors were indeed on the "front lines," but to the extent that they failed in their mission, heavy losses were inflicted on the population at large. The PCAOB should not ignore this record of performance when it decides the extent to which the audit standards-setting process should be influenced by currently practicing auditors and their organizations.

It should also be noted that audit standards inspired by directly interested parties might tend to soften independence requirements and tolerate audit procedures lacking in the necessary rigor – which were chosen as cost-cutting devices, and were, thus, endowed with legitimacy to better shield their practitioners from law suits resulting from audit failures.

The fact cannot be overlooked that, of the major reforms promulgated by Sarbanes-Oxley, those that bear directly on the practice of public accountants either constitute a refutation of positions long held by the accounting establishment, or add new measures that have been deemed necessary because of the inaction of the AICPA and its myriad committees on matters over which they have had the authority to act all along.

A case in point that deserves special attention – because of the long history behind it – is the provision in Sarbanes-Oxley that restricts public accounting firms to a very limited menu of non-audit services that may be offered to their audit clients.

The SEC had tried several times – beginning in the 1970s – to take action because of its concern that the proliferation of consulting services provided simultaneously with the audit practice might create conflicts of interest, thereby compromising the independence of the auditor, which is a basic requirement spelled out in the profession-s own code.

It is worth noting that even an AICPA in-house committee, whose warning in 1994 fell on deaf ears, pointed to the needs of users of financial statements and stated their concern "that auditors may accept audit engagements at marginal profits to obtain more profitable consulting engagements. Those arrangements could motivate auditors to reduce the amount of audit work and to be reluctant to irritate management [in order] to protect the consulting relationship."

Prior to the enactment of Sarbanes-Oxley, the accounting establishment, with the help of congressional allies, succeeded in warding off repeated regulatory attempts to ban public accountants from offering a wide array of consulting services to their audit clients.

A defeated SEC was, thus, forced time and again to settle for meaningless compromises, such as requiring public accounting firms to disclose separately audit and non-audit revenues, and setting up under the wings of the AICPA a short-lived Independence Standards Board (it lasted four years).

The ISB, whose mission was to establish auditor independence regulations, never addressed the pressing issue of maintaining independence in a practice that combines audit and consulting services. Instead, the independence board wasted time applying delaying tactics that resulted in "paralysis by analysis."

Studies were commissioned, such as a self-serving, one-sided white paper that was financed by the AICPA, which was summarily dismissed by the SEC for ignoring investor needs. Its co-author was the attorney and former SEC chair Harvey L. Pitt. As a private securities lawyer, Pitt-s clients included the AICPA and the Big Five.

The colossal failure of the ISB served as another one of those defining events that presaged the need for a far-reaching legislative reform that would include the formation of a truly independent oversight board with "real teeth."

With managing partners from three of the Big Five and the chief executive of the AICPA constituting half its membership, the ISB, which depended for its financing on the accounting profession, was destined to fail, because it lacked the requisite independence. As a result, it became, for all practical purposes, another appendage of the AICPA, similar to other moribund organs, such as the Peer Review Committee, and the old, and by now defunct, Public Oversight Board.

Devoid of any real power and meaningful authority, lacking in public visibility, and totally dependent on the Big Five and the AICPA, these organs and several related committees provided the semblance and veneer of an extensive apparatus engaged in professional self-regulation. They routinely handed each other passing grades, all the while treating with special reverence the big firms, which could do no wrong.

A vast Potemkin Village, as it were, was blown away by audit failures that became household words: Waste Management, Enron, WorldCom, and the list goes on. Has the accounting establishment changed its ways? Not exactly, if we are to go by its recent campaign, behind the scenes, against the appointment of John H. Biggs to head the new oversight board.

The reason? Mr. Biggs- often-voiced objection – which he put into practice during his tenure as CEO of the big financial institution TIAA-CREF – to public accountants offering their audit clients extensive consulting services. (The good news, however, is that William J. McDonough, the former president of the Federal Reserve Bank of New York, who was finally appointed to head the board, is equally qualified for the job.)

Given its demonstrably poor record in matters of self-regulation, from audit standard-setting to peer review, it can be expected that offers by the institute, and the firms it represents, to "share the load" will be approached with great caution and much skepticism by the oversight board and its recently appointed chief auditor, Douglas R. Carmichael, who is held in high regard as an independent-minded academic theorist and an experienced practitioner.

Sarbanes-Oxley is, on the whole, a good piece of legislation. There is reason to hope that it will not be undone by careless delegation of duties and responsibilities to those who, having failed the public in the past, still need to be weaned from the practice of getting their way through heavy lobbying accompanied by strategically aimed cash contributions. This is not the way to regain what was lost: the public trust.

* Itzhak Sharav teaches accounting at the Columbia Business School. Formerly an auditor with The public accounting firm S.D. Leidesdorf and co. (now part of Ernst & Young), he has been a Card-carrying and dues-paying member of the AICPA since 1966.